In this pubication: Gold prices have fallen and broken below the 200-day moving average. This means that this year’s uptrend is over. We have revised downwards our gold price forecasts because we think that investors will continue to liquidate. Our year-end forecasts for 2016 and 2017 are USD 1,200 and 1,150.161012-Precious-metals-watch-Downward-revision-gold.pdf ()
Since 17 February 2016 we have been positive on gold prices because they broke above the 200-day moving average and overall drivers were more positive with a Fed rate hike being a distant prospect and other central banks easing. Gold prices mainly rallied because speculative investors turned positive also on the back of these expectations. This is despite weak jewellery and industrial demand. Gold prices peaked on 6 July 2016 at USD 1,375 per ounce. Since 27 September gold prices have fallen considerably by 6% and prices broke below the 200-day moving signalling the end of the uptrend this year. Hawkish Fed comments, disappointment on the action by the BoJ, expectations of ECB tapering, some better-than-expected US economic data releases and constructive sentiment on equity markets all weighed on gold prices.
Investor demand is the swing factor
Over the recent years, gold investor demand has been the swing factor determining the direction in gold prices. This is because investors can quickly have a change of heart and decide to close or to open positions. This results in flows exceeding the change in jewellery demand. Therefore, gold prices have been at the mercy of investor behaviour. We differentiate between demand for gold coins and bars (retail investment demand) on the one hand and futures and ETF gold demand on the other hand.
Decline in gold bar demand overshadows gold coin demand…
Overall, the sum of gold bars and gold coins traded has declined substantially since the peak in June 2013 (see graph above). This can mainly by attributed to the sharp decline in demand for gold bars. Demand for gold bars in the world has clearly declined driven by India and China (see graphs below). This has more than overshadowed the positive trend in demand for gold coins. Investors buy these bars to store value as they are concerned about the long-term impact of loose monetary policy and systemic risks. Gold bars are, obviously, a more efficient way to store wealth than a large amount of coins. At the same time it is more costly to do so. We don’t expect a substantial pickup in the demand for gold bars this year or next year.
However, demand for gold coins has risen substantially. In the current environment some investors and consumers are concerned about the actions of central banks, concerns about the banking sector and the impact of Brexit. These investors will likely buy gold coins. In addition, a declining trend in the Chinese yuan will likely also support demand for gold coins. As we expect a relatively constructive investor sentiment and the absence of a sharp Chinese yuan devaluation, the interest in gold coins could ease.
…and positioning in gold futures and gold ETFs are enormous
Investors who buy gold via the futures or ETFs can make up their mind relatively quickly, especially the professional investors who operate via the futures market. They evaluate gold as an investment asset compared to other assets. If they think it is relatively cheap or expect an improvement in the overall price outlook they buy. That is exactly what they did in the period January up to September. Gold was seen as a relatively cheap as asset with safe haven characteristics and attractive as monetary policy easing was set to continue and real yields were expected to move lower. In addition, the overall technical outlook also turned bullish. As a result, the total net-long gold positions in the futures market and total ETF positions increased strongly pushing gold prices higher (see graphs below).
What is worrying is that this substantial increase in positions “only” resulted in a USD 266 per ounce price increase (31 Dec 2015 – 27 September 2016). This highlights that the bullish stance among investors was fighting the negative trend in jewellery demand, industrial demand and demand for gold bars. This leaves us wondering what would happen if investor give up on gold altogether? The drop in gold prices since 27 September 2016 was the result of a relatively small position liquidation. If the positions in the futures market would be liquidated to the long-term average of around 100’000 contracts, prices will likely be back at the level we started this year.
We need to assess the likely actions of the professional investor. We think that it is unlikely that investors will add to their positions in short-term, which means that they will sell on rallies. First of all, net-long positions are already extreme. Second, they have been completely off guard by the pace of the fall in gold prices lately. This makes them very uncomfortable.
In what environment will they keep their positions (this means that prices will stay around current levels) and in which situation will they become net sellers. In the table below we have defined two scenario’s. First, is the ideal gold scenario where gold prices should rise. The second scenario is our base case scenario.
If we compare the ideal investment environment for gold and our base case the risks clearly point to the downside. If we take the huge position overhang and nervousness among gold investors into account, gold prices will likely first drop another USD 100-150 before some price recovery will take place. Therefore, we have revised downwards our gold forecasts. In a coming publication we will focus on silver, platinum and palladium price outlook.